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Stockholders’ Equity
Stockholders: Owners of a corporation Have a residual interest in assets after liabilities are
satisfied Stockholders’ equity:
Two major components Contributed capital Retained earnings
LO 1
Stockholders’ Equity
Contributed Capital: Amount a corporation receives from the sale of
stock (common or preferred) to the stockholders Additional Paid-In Capital : amount received at
issuance that exceeds the par value of the stock Retained earnings:
Amount of net income, over the life of the company not paid out as dividends
An important link between the income statement and the balance sheet
Stockholders’ Equity on the Balance Sheet
The basic accounting equation:
Two major components or subcategories:
Assets = Liabilities + Stockholders’ Equity
Components of the Stockholders’ Equity Section of the Balance Sheet
Number of Shares Par Value Additional Paid-In Capital Retained Earnings
Contributed Capital
Common stock Carries voting rights The common stockholders elect the corporation’s
officers • Establish its bylaws and governing rules
Preferred stock Flexible and tailored to a company’s needs Preference in dividends
Number of Shares
Authorized shares: the maximum number of shares a corporation may issue as indicated in the corporate charter
Issued shares: the number of shares sold or distributed to stockholders
Outstanding shares: the number of shares issued less the number of shares held as treasury stock
Par Value
An arbitrary amount that represents the legal capital of the firm
Stated on the face of the stock certificate Also called “stated value” Amount presented in the stock account
Additional Paid-In Capital & Retained Earnings
Additional paid-in capital: the amount received for the issuance of stock in excess of the par value of the stock
Retained earnings: net income that has been made by the corporation but not paid out as dividends Not necessarily available to stockholders May be used for purchase of assets, the retirement of
debt, or other financial needs
IFRS and Stockholders’ Equity Items that have characteristics of both debt and
equity Example: Convertible bond is similar to debt but
because it will become stock if converted, it also has the characteristics of equity
International accounting rules An item having both debt and equity component should
be separated into two parts—liability and stockholders’ equity
U.S. accounting standards Do not require to be recorded as a separate amount Recorded as either liability or stockholders’ equity
Preferred Stock
Flexible and tailored to a company’s needs Dividends must be distributed to preferred
stockholders before common stockholders Right to the company’s assets before the
common stockholders during liquidation The dividend rate may be stated in two ways:
Percentage of the stock’s par value Per-share amount
LO 2
Preferred Stock Additional Terms and Features
Convertible: allows preferred stock to be exchanged for common stock
Redeemable: allows stockholders to sell stock back to the company
Callable: allows the firm to eliminate a class of stock by paying the stockholders a specified amount
Preferred Stock Additional Terms and Features
Cumulative: the right to dividends in arrears before the current-year dividend is distributed
Participating: allows preferred stockholders to share on a percentage basis in the distribution of an abnormally large dividend
Issuance of Stock
Issued for cash or for noncash assets When issued for cash:
Par value reported in the stock account Amount in excess of par is reported in the Paid-In
Capital account When exchanged for noncash items:
Recorded at the fair market value of the stock or the assets received, whichever is most readily determined
LO 3
Example 11.1—Recording StockIssued for Cash
Assume that on July 1, a firm issued 1,000 shares of $10 par common stock for $15 per share
Example 11.2—Recording Stock for Noncash Consideration
Assume that on July 1, a firm issued 500 shares of $10 par preferred stock to acquire a building. The stock is not widely traded, and the current market value of the stock is not evident. The building has recently been appraised by an independent firm as having a market value of $12,000
Treasury Stock Represents the corporation’s own stock, previously issued to
shareholders, repurchased from stockholders and not retired, but held for various purposes
Repurchase is recorded as a debit to Treasury Stock, a contra-equity account
For an amount to be treated as treasury stock: It must be the corporation’s own stock It must have been issued to the stockholders at some point It must have been repurchased from the stockholders It must not be retired, but must be held for some purpose
LO 4
Example 11.3—Recording the Purchase of Treasury Stock
Assume that the Stockholders’ Equity section of Rezin Company’s balance sheet on December 31, 2014, appears as follows:
Example 11.3—Recording the Purchase of Treasury Stock (continued)
Assume that on February 1, 2015, Rezin buys 100 of its shares as treasury stock at $25 per share.
Stockholders’ Equity Section
The Stockholders’ Equity section of Rezin’s balance sheet on February 1, 2015, after the purchase of the treasury stock
Retirement of Stock
Repurchase of stock with no intention of reissuing To eliminate a particular class of stock or group of
stockholders The general principle for retirement of stock is the
same as for treasury stock transactions No income statement accounts are affected Effect is reflected in the Cash account and the
Stockholders’ Equity accounts
Cash Dividends
Declared only if a company has sufficient cash available and adequate retained earnings
Not an expense on the income statement Date of declaration: cash dividends are declared Payment date: cash dividends are paid Date of record: dividend is paid to the
stockholders who own the stock as of this date
LO 5
Dividend Payout Ratio
The annual dividend amount divided by the annual net income
Ratio for many firms is 50% or 60% and seldom exceeds 70%
Annual DividendAnnual Net IncomeDividend Payout Ratio =
Example 11.4—Recording the Declaration of a Dividend
Assume that on July 1, the board of directors of Grant Company declared a cash dividend of $7,000 to be paid on September 1.
Example 11.5—Computing Dividend Payments for Noncumulative Preferred Stock Assume that on December 31, 2014, Stricker Company has
outstanding 10,000 shares of $10 par, 8% preferred stock and 40,000 shares of $5 par common stock. Stricker was unable to declare a dividend in 2012 or 2013 but wants to declare a $70,000 dividend for 2014
Example 11.6—Computing Dividend Payments for Cumulative Preferred Stock If the terms of the stock agreement in Example 11.5
indicate that the preferred stock is cumulative, the preferred stockholders have a right to dividends in arrears before the current year’s dividend is distributed
Stock Dividends
The issuance of additional shares of stock to existing stockholders
Firms use stock dividends for several reasons Do not require the use of cash Reduce the market price of the stock• The lower price may make the stock more attractive
Do not represent taxable income to recipients
LO 6
Example 11.7—Recording a Small Stock Dividend
Assume that Shah Company’s Stockholders’ Equity category of the balance sheet appears as follows as of January 1, 2014:
Example 11.7—Recording a Small Stock Dividend (continued)
Assume that on January 2, 2014, Shah declares a 10% stock dividend to common stockholders to be distributed on April 1, 2014. Small stock dividends (usually those of 20% to 25%) normally are recorded at the market value of the stock as of the date of declaration. Assume that Shah’s common stock is selling at $40 per share on that date
Example 11.8—Recording the Declaration of a Large Stock Dividend
Assume that instead of a 10% dividend, on January 2, 2014, Shah declares a 100% stock dividend to be distributed on April 1, 2014. The stock dividend results in 5,000 additional shares being issued and certainly meets the definition of a large stock dividend
Example 11.8—Recording the Declaration of a Large Stock Dividend (continued)
The effect when the stock is actually distributed is as follows:
The Stockholders’ Equity category of Shah’s balance sheet as of April 1 after the stock dividend is as follows:
Stock Splits
The creation of additional shares of stock with a reduction of the par value of the stock
LO 7
Example 11.9—Reporting a Stock Split Refer to the Shah Company in Examples 11-7 and 11-8. Assume that on
January 2, 2014,Shah issued a 2-for-1 stock split instead of a stock dividend. The split results in an additional 5,000 shares of stock outstanding but is not recorded in a formal accounting transaction. Therefore, the Stockholders’ Equity section of Shah Company immediately after the stock split on January 2, 2014, is as follows:
Statement of Stockholders’ Equity
Explains the reasons for the difference between the beginning and ending balances for all accounts in the Stockholders’ Equity category of the balance sheet
LO 8
Comprehensive Income
Total change in net assets from all sources except investments by or distributions to the owners
Important measure of a company’s profitability One-statement approach
Showed at the bottom of the income statement Two-statement approach
Statement of Comprehensive Income must be presented (indicated in Exhibit 11.4—next slide)
Exhibit 11.4—The Relationship between the Income Statement and the Statement of Comprehensive Income
Book Value Per Share
Rights of each share of stock to the net assets of the company
If preferred stock is present, stockholders’ equity must be adjusted to reflect its liquidation value
LO 9
Calculating Book Value When PreferredStock Is Present
Exhibit 11.5—Workout Wonders’ Stockholders’ Equity Section
$13,972 − $500 = $13,472 million common stockholders’ equity
$13,472 /1,679 = $8.02 Book Value per Share
Market Value per Share
The selling price of the stock as indicated by the most recent transactions
More meaningful measure of the value of the stock
Example: the listing for Nike Inc. stock on the Internet may indicate the following:
Sole Proprietorships
Business owned by one person The owner have an unlimited liability
Not a separate entity for legal or tax purposes Assets and liabilities of the owner must be kept
separate from the business Owners’ equity is one account—the owner’s
capital account
LO 11
Example 11.10—Recording Investments in a Sole Proprietorship
Assume that on January 1, 2014, Peter Tom began a new business by investing $10,000 cash
Example 11.10—Recording Investments in a Sole Proprietorship (continued)
Assume that on July 1, 2014, Peter Tom took an auto valued at $6,000 from the business to use as his personal auto
Example 11.10—Recording Investments in a Sole Proprietorship (continued)
The Peter Tom, Drawing account is a contra-equity account. An increase in the account reduces the owner’s equity. At the end of the fiscal year, the drawing account should be closed to the capital account and the effect is as follows:
Example 11.10—Recording Investments in a Sole Proprietorship (continued)
Assume that all revenue and expense accounts of Peter Tom Company have been closed to the Income Summary account, resulting in a balance of $4,000, the net income for the year
Example 11.10—Recording Investments in a Sole Proprietorship (continued)
The Owner’s Equity section of the balance sheet
Partnerships More than one owner Separate capital account is maintained for each
partner, as well as separate drawing accounts Partnership agreement governs how income
(losses) will be distributed Unlimited liability Limited life Not taxed as a separate entity
Income is taxed on each owner’s tax return
Partnership Agreement
Specifies how much the owners will invest, what their salaries will be, and how profits will be shared
Example 11.11—Recording Investments in a Partnership
Assume that on January 1, 2014, Paige Thoms and Amy Rebec begin a partnership named AP Company. Paige contributes $10,000 cash, and Amy contributes equipment valued at $5,000
Example 11.11—Recording Investments in a Partnership (continued)
Assume that on April 1, 2014, each owner withdraws $2,000 of cash from AP Company
Distribution of Income Assume that AP Company has $30,000 of net income for the period
and has established an agreement that income should be allocated evenly between the two partners, Paige and Amy. Each capital account would be increased by $15,000
Distribution of Income (continued) Paige and Amy may specify that all income of AP Company should be
allocated in a 2-to-1 ratio, with Paige receiving the larger portion
Distribution of Income (continued) Assume that the partnership agreement of AP Company
specifies that Paige and Amy be allowed a salary of $6,000 and $4,000, respectively; that each partner receive 10% on her capital balance; and that any remaining income be allocated equally. Assume that AP Company has been in operation for several years and that the capital balances of the owners at the end of 2014, before the income distribution, are as follows:
Paige Thoms, Capital $40,000 Amy Rebec, Capital 50,000
Distribution of Income (continued) If AP Company calculated that its 2014 net income (before
partner salaries) was $30,000, income would be allocated between the partners as follows:
Distribution of Income (continued) Paige Thoms, Capital would be increased by $15,500, and Amy Rebec,
Capital, by $14,500. The effect of closing the Income Summary account to the capital accounts is as follows:
This indicates that the amounts of $15,500 and $14,500 were allocated to Paige and Amy, respectively. It does not indicate the amount actually paid to (or withdrawn by) the partners.